Posts Tagged ‘actuary’

The Broomball Coefficient of Anticipation

January 18, 2010

I graduated with my BS in Business from Lake Superior State University in Sault Ste. Marie, MI.  Located in the north-eastern most corner of Michigan’s Upper Peninsula, it is a place of serious winter and unless you figure out things to do when it’s cold out you will never venture far from your dorm for months at a time.  The history of broomball is sketchy, but it is enough to say that it is one of those ideas that creative folks in cold places hatch to have fun in an otherwise hostile environment.

Broomball is played on the ice and has goals similar to hockey.  The players wear tennis shoes and use what looks like a corn broom cut off at the stitches to direct a small ball into the goal.  The action is much like hockey with one notable exception.  Tennis shoes don’t get any traction on ice.  That lack of precision in movement contributes to a need for planning plays that goes beyond anything in hockey.  Beside the typical dynamics at play in any sport, now you have the reduced ability to execute precisely.  You must introduce a “factor” into each play that actually causes you to execute before the precise moment you would normally execute the play because the ice is slippery.  In order to figure out just how much anticipation is needed you spend a lot of time on your butt or sliding past the goal or shooting and missing altogether.

Sounds like the real world doesn’t it!

When you are planning risk transfer and risk financing mechanisms there are numerous financial, actuarial and catastrophic loss models that can help you to make sound decisions; but at the end of the day there is a lot which cannot be completely controlled.  I call this the “Broomball Coefficient of Anticipation”.

The reason why insurance is a prime example of this coefficient in action is that its modeling is almost exclusively retrospective.  Insurers price off of historic loss histories, expectations of future catastrophic loss are based on where they have happened in the past, essentially navigating forward by looking in the rear view mirror.  Don’t get me wrong, since none of us have crystal balls to predict the future we have to have something to hang out hats on and, at least statistically, the past has been a pretty good indication of future events.

If we were operating in an environment where we had the sure footing of a manicured baseball diamond or the turf of a football stadium or the pitch of a soccer field we could execute our plays instantaneously and with precision.  But in insurance we are playing on ice in our sneakers.  One of the tenets of the “Broomball Coefficient of Anticipation” is that if you wait until all the scientific loss models show its time to execute, it’s already too late.  That’s why you see the insurance industry as a whole constantly being reactive instead of proactive with just a few exceptions.

Of all the segments of the insurance industry, alternative risk is the most likely candidate to take the Broomball Coefficient and use it to best effect.  Captive insurance companies are the most efficiently capitalized, agile and responsive insurance mechanisms in the industry.  Because they are responsible for serving the needs of a single client or a very small clientele they can quickly execute on initiatives to meet strategic goals and can often do so in anticipation of need as opposed to in response to a need.

The only thing lacking to most captive insurers is a partner that knows how to execute while running full speed on ice in sneakers.

Email me at dennis.silvia@cedarconsulting.net if you would like to discuss this more.

Education is Key to Execution

January 8, 2010

Education is the key to being able to effectively implement and execute a sophisticated risk management regime like a captive insurance program.  This doesn’t only apply to the accounting and insurance professionals that are involved in the day-to-day operations of these types of programs.   It also applies to the risk managers who represent companies that own them and to insurance producers that help to set them up.

There are several venues to learn about captives and how they are used.  The International Center for Captive Insurance Education (ICCIE) provides an online platform of coursework that leads to the Associate in Captive Insurance (ACI) designation.  I am on the faculty for this program and it is an excellent course of study for accounting, insurance and business professionals to get a solid foundation of captive insurance concepts.  You can find more information at http://www.iccie.org/

Several associations provide annual conference opportunities that are full of great educational content.  The Vermont Captive Insurance Association, the Bermuda Captive Conference and the Cayman Captive Conference are all venue-oriented educational experiences and are excellent for delivering timely information on emerging industry issues.

For more general insurance and underwriting educational topics there are several continuing education websites that can provide the ongoing training needed to maintain licenses and credentials.  I sponsor one of these websites at http://cedarconsulting.360training.com

Finally, industry service providers organize conferences that have client education as their primary purpose.  USA Risk Group (www.usarisk.com), the largest independent captive services company, sponsors an annual educational conference for captive industry participants.  This type of conference is typically more focused on the practical nuts and bolts issues of captive insurance and the smaller group results in better access to speakers and service providers.   The conference is highly rated by participants.  This year’s conference will be held in Charlotte, NC at the Ballantyne Resort, May 26th-27th, 2010.  You can contact me by email at dennis.silvia@cedarconsulting.net for specifics on registration for this event.

Education in and of itself is worthless.  It’s not in the knowing, but rather in the application of the knowledge that yields results.  These educational opportunities will give you what you need not only to understand the concepts of captive insurance but to apply them to your circumstances.

Execution is always the factor that divides the successful and the wannabe.  Gain the knowledge you need but don’t forget to deploy that knowledge in a meaningful way to solve risk related problems for your organization.

All Your Eggs in One Basket

September 4, 2009

Don’t Put All Your Eggs in One Basket

Its easy to see how it happens.  Your insurance broker comes to you with a great idea about how to more efficiently finance and manage your insurance risk.  They bring in the brokerage’s experts to conduct feasibility studies and work with you to license a captive insurance company.  The have their reinsurance brokers place the reinsurance and have their captive manager take care of the regulatory and management operations.   Because of their fully integrated capabilities your broker has delivered a captive insurance solution entirely from within the broker’s organization.  That’s good, right?

One of the biggest decisions that face the owners of captive insurance companies is whether or not to consolidate all the insurance and captive management services in one basket.  There are some obvious advantages to doing this.  It is simpler, and may be less expensive initially to let your broker put your entire program together.  They may even be willing to do the feasibility work within the existing fee structures, only charging for the ongoing management and collecting the commissions on the reinsurance placements.  But what are the disadvantages?

  • When a captive insurance program is created entirely from within a single organization with no outside input then you get that organization’s cookie-cutter program.  They only do things a certain way and that is what you will get, whether its the best structure for you or not.
  • With no outside involvement there is no “gate keeper” making sure that the broker’s organization is doing everything it can to advantage the captive owner even if it means that it might disadvantage the broker’s organization.
  • Most broker organizations are limited in the number of domiciles that they can effectively do business in which means that they cannot be completely domicile neutral.  You may end up being steered to a domicile that suits their operational characteristics but may not be the best choice for your company.
  • Even in the best of brokerage organizations things slip through the cracks.  The broker is less likely to spend the same amount of time reviewing work done by an internal department then they might work from outside.  The checks and balances of having a diverse makeup in the captive’s support mechanisms are eliminated.
  • Pricing for captive services can often be overstated when billed all together as opposed to being presented on a line by line basis.
  • Brokerage organizations are typically polarizing in the industry.  Some companies get along well with other companies and frankly some don’t get along at all.  An independent manager can often involve service partners that a brokerage could not because of conflicts in corporate cultures.

In my consulting practice I have reviewed programs that have had the captive services completely integrated within one brokerage organization.   My reviews always turn up issues.  In one case a mismatch between the terms and conditions of the policies being written by the captive and the reinsurance treaty could have caused an enormous financial problem for the captive.  In an another case the overall charges for the program were much higher than average because they were being billed in a lump rather than being detailed line by line.

If you are considering a new captive program be sure to weigh the advantages and disadvantages of an integrated approach.  Try to involve at least one outside advisory component to the program in order to mitigate the potential problems.  If you already have an integrated program, hire a consultant to do a review of your captive and make suggestions on structure and operations as well as benchmark your costs.  Its never a good idea to have all your eggs in one basket.

New Sheriff in Town

April 29, 2009

Depending on which side of the fence you live on you either see underwriters as the scourge of the industry because they get in the way of your producing business or they are the saviors of the industry because they are the gatekeepers protecting the company from risk.  This has been an age old battle and frankly I’ve always seen it as beneficial, helping to make sure that insurance companies write as much good business as they can get their hands on.  If producers want to write everything and underwriters don’t want to write anything then somewhere in between is a healthy balance that allows for something to be written profitably.

The compromise that a risk underwriter can strike with a producer when considering an application for insurance is predicated on the theory of large numbers and the recognition that over a large enough book of business and time that a measured approach to risk consideration will yield profit.  Sometimes they will get it right and sometimes they will get it completely wrong, but on average it will work out.  Risk underwriters are allowed to make a certain number of  mistakes and still be seen as successful.

There is a new underwriting Sheriff in town now and this one isn’t allowed to get it wrong, ever, and its causing a lot of consternation in the alternative risk and captive insurance arenas.  Credit underwriting has long been like a camel poking its nose under the traditional insurance tent.  Granted, there is a correlation between credit worthiness and risk quality and it should be considered as one of the underwriting criteria, but because of the current financial crisis it has taken on a life of its own particularly in risk sensitive programs.

In large deductible and captive insurance programs the insurance company providing coverages  must consider the credit worthiness of the risk taker as a part of the overall risk they are assuming.   These risk transfer programs have elements of both underwriting and credit risk.  Balancing the underwriting of risk has been dealt with effectively over the years by recognizing that if you prudently insure a large enough pool of risk that you will end up winning over time and making a profit.

Credit risk is still a relatively new stand alone discipline and as a result it is still trying to get its footing on what has been a slippery economic slope.  Unlike their risk underwriting associates, credit underwriters don’t have the flexibility to get it wrong.  Credit underwriting to this standard would be like a risk underwriter looking for loss picks in the 90% actuarial range.  It stops being a pooling mechanism at that level and the client might as well completely self insure.  Combine this with the enhanced regulatory and compliance environment that we find ourselves in and we have a big problem when it comes to deductible and captive insurance programs.  Rather than assume a measured degree of credit risk this new breed of underwriter is seeking full collateralization of every deal. Its a bit like the joke that a banker won’t loan you money until you can prove that you really don’t need it.

The solution to this problem is for insurance credit underwriters to embrace the theory of large numbers and to recognize that they can assume a measured degree of risk and on an overall book of business end up being whole.  They, and their managers, must be willing to accept some degree of loss as a part of their cost of doing business.  Until that happens alternative risk program development will languish for all except those that don’t really need it!

Do That Voodoo That You Do So Well

March 26, 2008

There are many reasons why an insured might consider being involved in a captive insurance program.  Over the next few days I’ll try to unpack those reasons in a way that makes sense.  Today I want to address the potential premium advantages of a captive.

I think one of the most frustrating things about captive insurance is that it is so misunderstood.  There is a sense of smoke and mirror magic about how a captive might solve the risk financing ills of an insured and often captives come out of the agent’s bag of tricks as a means of reducing premium for loss-distressed clients.  Let’s try to debunk some of the mystery around who should be involved in these kinds of insurance programs in today’s post.

In any insurance product offering, captive or traditional, there are several elements to cost that are standard.  There is a cost associated with paying claimants for loss and the costs associated with adjusting those claims.  There is a cost to the administrative work associated with the underwriting and issuance of policies and to the maintenance of compliance and regulatory issues associated with licensing in the various states.  There are premium taxes, boards, bureaus and assigned risk charges levied on the policy’s premiums.  While the litany of frictional costs on an insurance program are standard, the percentage that each of these items consume is relative.

Assuming that a traditional insurer has made his frictional cost as efficient as possible the one cost that has a sense of uncertainty is the costs associated with the payment to claimants for damages they sustain through the fault of insureds.  Actuarial work is either Voodoo or science depending on who you talk to, but it is an insurer’s best method for determining the correct price to charge for the loss cost element of a policy.  Actuaries pour over loss data and determine statistically, based on a specific set of circumstances, what the correct costs per exposure unit should be for risk in a particular market.  The “Theory of Large Numbers” is the basis of actuarial accuracy.  It says that the more data you pour into the analysis the more accurate the results will be for the insurance company taking risk on those results.  Herein lies the good news for captive insurance!

 

The Dart Board Theory

If insurance companies price their products based on pooling a large database of losses in a particular industry then their pricing is an “average” for that industry.  If you are an average risk then you are paying the right amount of premium based on the risk you present.  If you are below average then you are getting a deal and if you are above average, you are paying more than you should be.  Obviously insurance companies mitigate this inequity by offering credits and debits off of the standard price for accounts with certain attributes.  These adjustments are most prevalent when there is a lot of competitive pressure either because of a soft insurance market or a lot of demand on the part of insurance companies for the type of risk being considered.    If your client is in a market segment that is not highly sought after by insurance companies they can often be left behind in the pricing rush.

Back to our dartboard.  Imagine a horizontal line across the center of the board.  Any darts above the line are above average and any darts below the line below average.  The problem here is that the pricing for all the darts is essentially the same within +/- 20%.  The over-pricing for the really good accounts is being used to offset the under-pricing for the not-so-good accounts.  From the insurance company’s perspective the result is good, on average just what they expected, and the actuarial staff will probably get a great bonus.  The insured’s perspective depends on where they fall on the dartboard.  Poor risk management is rewarded and good risk management is punished.

So, what have learned about the best clients for a captive program?  They are the ones that are consistently good performers, above average from a risk management perspective and typically involved in activity that the insurance market does not actively compete for.  Think trucking, medical malpractice, residential construction etc…. Now, here is where agents get it wrong.  Not ALL companies in these industries should be involved in alternative risk structures, only those who have earned their chops from a risk management perspective.  Certainly no client with a history of poor loss control and risk management results should consider an alternative risk structure until they have fixed their problems and seen positive result trends.

By assuming risk where there is a relatively high frequency of low severity loss potential a good risk is able to leverage their investment in risk management and loss control to reduce the cost of risk financing by a factor equal to the amount that they are better than the industry average price.